Gross domestic product (GDP) is the total market value of the goods and services produced by a nation’s economy during a specific period of time. It includes all final goods and services—that is, those that are produced by the economic resources located in that nation regardless of their ownership and that are not resold in any form.[1]

The GDP is usually measured for the period of one year. Lew Rockwell writes that "the Gross Domestic Product statistic is riddled with composition fallacies inherent in the Keynesian model. Government spending is considered part of aggregate demand, and no effort is made to account for the destructive costs of taxation, regulation, and redistribution."[2]

Contents

Measuring GDP

The GDP can be arrived at by three separate means: as the sum of goods and services sold to final users, as the sum of income payments and other costs incurred in the production of goods and services, and as the sum of the value added at each stage of production. Although these three ways of measuring GDP are conceptually the same, their calculation may not result in identical estimates of GDP because of differences in data sources, timing, and estimation techniques.

In general, the source data for the expenditures components are considered more reliable. In this method, the GDP is calculated by the Bureau of Economic Analysis as following:[3]

Gross private fixed investment, which measures additions and replacements to the stock of private fixed assets without deduction of depreciation. Nonresidential fixed investment measures investment by businesses and nonprofit institutions in nonresidential structures and in equipment and software. Residential fixed investment measures investment by businesses and households in residential structures and equipment, primarily new construction of single-family and multifamily units.

Change in private inventories, which measures the change in the physical volume of inventories owned by private business valued in average prices of the period.

Government consumption expenditures and gross investment, which comprises two components. Current consumption expenditures consists of the spending by general government in order to produce and provide goods and services to the public.

Net exports of goods and services, which is calculated as exports less imports. Exports consist of goods and services that are sold or transferred by U.S. residents to foreign residents. Imports, which are subtracted in the calculation of GDP, consist of goods and services that are sold or transferred by foreign residents to U.S. residents.

GDP Numbers are Flawed

In theory, the GDP is the sum total of all value-added transactions within our country in any given year.

As an example, the reported number for 2003 was a GDP of $11 trillion, implying that $11 trillion of money-based, value-added economic transactions had occurred. However, nothing of the sort happened.

First, that 11 trillion included $1.6 trillion of imputations, where it was assumed that economic value had been created but no actual transactions took place.

The largest of these imputations was the "value" that the owner of a house receives by not having to pay themselves rent. If you own your house free and clear, the government adds how much they think you should be paying yourself rent to live there and adds that amount to the GDP.

Another is the benefit you receive from the "free checking" provided by your bank, which is imputed to have a value, because if it weren’t free, then you’d have to pay for it. So that value is guesstimated and added to the GDP as well. Together, just these two imputations add up to over a trillion dollars of our reported GDP.

Next, the GDP has many elements that are hedonically adjusted. For instance, computers are hedonically adjusted to account for the idea that, because they are faster and more feature-rich than in past years, they must be more additive to our economic output.

So if a thousand dollar computer were sold, it would be recorded as contributing more than a thousand dollars to the GDP. Of course, that extra money is fictitious, in the sense that it never traded hands and doesn’t exist.

What’s interesting is that for the purposes of inflation measurements, hedonic adjustments are used to reduce the apparent price of computers, but for GDP calculations, hedonic adjustments are used to boost their apparent price. Hedonics, therefore, are used to maneuver prices higher or lower, depending on which outcome makes thing look more favorable.

So what were the total hedonic adjustments in 2003? An additional, whopping $2.3 trillion. Taken together, these mean that $3.9 trillion, or fully 35% of the reported GDP, was not based on transactions that you could witness, record, or touch. They were guessed at, modeled, or imputed, but they did not show up in any bank accounts, because no cash ever changed hands.

As an aside, when you hear people say things like "our debt to GDP is still quite low" or "income taxes as a percentage of GDP are historically low," it’s important to remember that because GDP is artificially high, any ratio where GDP is the denominator will be artificially low.

Now let’s tie in inflation to the GDP story. The GDP you read about is always inflation-adjusted and reported after inflation is subtracted out. This is called the real GDP, while the pre-inflation adjusted number is called nominal GDP. This is an important thing to do, because GDP is supposed to measure real output, not the impact of inflation.

For example, if our entire economy consisted of producing lava lamps, and we produced one of them in one year and one of them the next year, we’d want to record our GDP growth rate as zero because our output is exactly the same.

So if we sold a lava lamp for $100 one year but $110 the next, we’d accidentally record 10% GDP growth if we didn’t back out the price increase. So in this example, the real lava lamp economy has a value of $100, while the nominal lava lamp economy is $110. But all we care about is the real economy, because we’re trying to measure what we actually produced.

Ah! Now we can begin to understand the second powerful reason that DC loves a low inflation reading. It’s because GDP is expressed in real terms. In the 3rd quarter of 2007, it was reported that we experienced a very surprising and strong 4.9% rate of GDP growth. At the time, there were many proud officials declaring that certain tax cuts were responsible for this excellent news, and so forth. Less well reported was the fact that nominal GDP was 5.9%, from which was deducted the jaw-droppingly low inflation reading of 1%, giving us the final result of 4.9%.

In order to believe the 4.9% figure, you have to first believe that our nation was experiencing a 1% rate of inflation during the same period that oil was approaching $100/barrel and inflation was obviously and irrefutably exploding all over the globe.

Note the so-called GDP deflator, which is the specific measure of inflation that is subtracted from the nominal GDP to yield the reported real GDP. For the past fifteen quarters the Bureau of Economic Analysis has been serenely and systematically subtracting lower and lower amounts of inflation[citation needed], which simply flies in the face of both real-world inflation data and common sense. Each percent that inflation is understated equals a full percent that GDP is overstated.

Keep this in mind when you next read about how "our robust economy is still expanding."[4]

Measuring growth

Economic growth is often measured by the Gross domestic product. It does not represent production, but overall spending, and is dependent on the techniques that are applied to the calculation of the respective price indices. To calculate a "real GDP", the statistical offices create a basket of goods and compare the prices of the goods in this basket to the respective reference periods. But there is no objective representative basket of GDP other than as a statistical construct based on many disputable assumptions, and there is no common standard which would allow the comparison of one period’s production to the other when in fact current output in terms of new, obsolete and modified goods and services is quite different from that of the past. Money prices do not measure anything. Prices only have a meaning as relative prices as they reflect the exchange ratios on the market.

In a private market economy the aims of economic activity are highly diverse and represent individual and subjective valuations. For an economy that is to serve multiple private needs, the calculation of economic growth makes little sense, if any at all. One may add up nationwide the various monetary prices of the goods and services that were sold, but besides the aggregation of the monetary values of diverse items – what is the true and reliable informational value of this exercise?

Each good and service has a different value for each user, and there is no common standard of value available. This is even more so the case, when new products and new kinds of services come to the market. Valuations are not only heterogeneous among persons, but also differ for the same person according to the specific circumstances. Human beings have different needs and wants in different situations, and they experience changes of taste over time. Quality itself is not an attribute inherent to the things, but it is a valuation by economic actors.[5]

When Sir John Cowperthwaite, who is credited for turning Hong Kong into a thriving global financial centre, was asked what was the one reform that he was most proud of, he said "I abolished the collection of statistics." Sir John believed that statistics are dangerous, because they enable social engineers of all stripes to justify state intervention in the economy.[6]

History

This concept of the GDP can be traced back to 1932, when the Commerce Department hired economist Simon Kuznets to produce an end measure of the economy. Kuznets's passion was collecting and organizing the national-income accounts of the United States. On that front, Kuznets helped the Commerce Department standardize the measurement of gross national product (GNP, yesterday's GDP), but even he disapproved of using it as a general indicator of national welfare:[7]

The welfare of a nation can, therefore, scarcely be inferred from a measurement of national income as defined above.

The abuses of national income estimates arise largely from a failure to take into account the precise definition of income and the methods of its evaluation which the estimator assumes in arriving at his final figures.[8]